On Tuesday, RBI Governor Raghuram Rajan surprised the markets with a 50 basis point — or half a per cent — cut in the key policy rate, the repo rate, which is seen as a booster to sentiment and hopefully will translate into higher demand.
What does the rate cut and the other policy measures Rajan announced today mean to consumers and the broader economy?
Cut in repo rate by 50 basis points: By cutting its key policy rate, the RBI is signalling a lower cost of funds for banks which can borrow from the central bank. In turn, the lower borrowing costs should translate into lower rates at which consumers who want to buy a home, consumer durables or vehicles can access credit.
That will add to demand in the economy and boost revenues. For the government too — the biggest borrower — there should be gains because of lower yields on bonds. However, for savers who have enjoyed relatively high effective rates on their deposits, it will mean that they have to settle for lower rates unless credit growth picks up. The deep cut also points to a possible reduction in interest rates on small savings schemes down the line with enough indications being given by the RBI and the government.
Higher investment by foreign investors in government bonds: This will be an additional source of investment besides banks or insurance companies for government bonds or borrowings. It should also help in terms of keeping interest rates stable. For consumers or corporates, stable rates should help influence their investment decisions.
Large exposures framework and enhancing credit supply through market mechanism: In India, unlike many other markets, corporates access a large part of their funding needs from banks. In the West, much of their borrowings are through the market.
The proposal now to nudge large corporates with borrowings from the banking system above a cut-off level to tap the market will mean two things: one, it will reduce the risk for banks given their huge exposure to corporates. Two, this should logically then lead to the availability of more credit or loans to small and medium sized business and other customers. It should also help in the development of a robust corporate bond market in the medium to long term.